Historically, those customers who were not eligible for experience or retrospective rating plans lacked programs that provided incentives to control losses and lower their insurance costs. During the late 1980’s and early 1990’s, the Small Business Association began an initiative to encourage State Insurance Departments to review this dilemma and implement programs that will address these issues. As a result, small deductible programs were born. These programs give employers the opportunity to gain some premium relief through deductible premium credits by electing to pay a selected deductible amount.
Currently, most states have implemented a WC Small Deductible Program. The benefits of which the deductible will apply vary by state and in most cases will be one of the three following types:
- Indemnity Benefits Deductible – where the deductible will apply to indemnity benefits only
- Medical Benefits Deductible – where the deductible will apply to medical benefits only
- Claims Deductible – also referred to as a Benefits Deductible. The deductible will apply to both medical and indemnity benefits combined
Critical Program Features
Mandatory vs Optional Offer
In several states, insurance companies are under no obligation to offer the small deductible program while in others they are. However, the rules are not clear as to what exactly constitutes an “offer.” The interpretation of this rule varies by state. Some states are interpreting the wording very loosely meaning that as long as the customer is aware that the program is available then that constitutes an offer. While other states are holding the wording to its strictest terms and interpreting that if a carrier is providing any type of quote to a customer (new business or renewal), then one of the options must be the small deductible program. In some states insurance companies are obligated to provide the deductible program to their customers only when they receive a written request from the customer.
Currently, there are three types of “mandatory” offer categories as follows:
- Mandatory where the insurer has to offer the customer a small deductible program (DE, FL, GA, HI, IL, MA, MT, NY, OK, & TX)
- Mandatory, only if the insurer determines that the customer is financially stable to be responsible for the deductible amount (AL, AR, CO, KY, ME, MN, NE, NM, OR, & SC)
- Mandatory, only if the customer requests for a small deductible program (NH & PA)
Here are the current Optional Offer States:
- AZ, CA, CT, IN, IA, KS, MD, MO, NV, NC, RI, SD, TN, UT, & VA
Small Deductible Programs – Size of Deductible
The size of the deductible that constitutes a “Small Deductible” varies by state, but most states consider anything starting at $500 and ranging to $5,000 to be a small deductible.
Net vs Gross Reporting Requirements
In addition to individual states electing mandatory or optional status for small deductible programs, each state also requires insurance companies to report loss information to the NCCI for the computation of the WC experience modification on a Net or Gross basis.
Those states that require that the losses are to be reported on a “gross” basis means that the loss amounts reported to the NCCI should not be reduced by the amount of the deductible reimbursement from the customer. When customers elect a small deductible for a gross reporting state, they receive a deductible credit in the rating of their premium.
There are 12 states that require reported losses to be “net.” This means that the calculation of the experience rating modification will not include customer deductible reimbursements. Customers who purchase a small deductible option with a “net” loss reporting provision will receive a deductible credit to their premium in addition to a distorted experience rating modification factor. States requiring losses to be reported on a net basis are AL, CO, FL*, GA, HI, IA, KS, KY, ME, NM, OK, & SC. FL* net reporting is for the $2,500, small deductible option only.
Medium Deductible Programs
Medium Deductible Programs (those ranging in deductible values of $10,000 to $75,000) are not mandatory, and are available only at the discretion of the insurance carrier. Where available, the 3 types of deductibles (Indemnity, Medical, or Benefits) can be negotiated with the carrier, with the Benefits Deductible being the most common. Considering deductibles of this size range, it is not uncommon for carriers to require security in the form of an escrow account or Letter of Credit/Bond or both. I’ll elaborate on security requirements in the next section regarding Large Deductible Programs.
Large Deductible Programs
The Large Deductible Policy (LDD) refers to a Standard Workers’ Compensation Policy including Deductible Endorsement(s). It is intended to provide the same coverages and services as a fully insured policy, yet allowing the insured to retain the liabilities for the loss dollars under the deductible limit. Under most endorsements, the insurance company agrees to handle all claims under the policy, and usually advances payment and seeks reimbursement for amounts paid under the deductible limit.
Large Deductible Programs typically start at $100,000, per claim, and go up from there. While some states do not allow LDD’s (like WI), most states just have minimum premium requirements for companies to qualify for an LDD. These requirements are based on standard premium size, and most start at $100,000 in premium, but some states (CA, CO, FL, NE, & NM) require up to $500,000 in premium to be eligible for an LDD. If a company has operations in multiple states, some of which don’t allow the LDD, multiple insurance policies can be written. Typically, a Guaranteed Cost policy is written for the states of operation that don’t allow an LDD, and all remaining states will be included on the deductible policy. As long as the same carrier is writing both policies, the claims administration is relatively seamless.
Because the insurance company is advancing claims payment and seeking reimbursement afterwards, virtually all LDD policies are securitized in the form of escrow accounts and Letters of Credit.
Escrow – an escrow is cash typically equal to an estimated amount of two months worth of claims payments. The escrow account is the insured’s money, and is refundable at the termination of the policy and subsequent closure of all claims.
Letter of Credit (LOC) – a letter of credit is a document issued by a bank that guarantees the payment of a customer’s draft; it substitutes the bank’s credit for the customer’s credit. The amount of the LOC is set by the insurance company and is usually equal to the amount of expected losses for the entire policy period. When qualifying for an LDD and security, make sure the bank or financial institution issuing the LOC meets the insurance company’s LACE rating requirements.
Basic LDD Formula
Manual Premium = [manual rate(s) x (payroll/$100)]
Subject Premium = Manual Premium – (Manual Premium x LDD Credit)]
Deductible Premium = Subject Premium x Experience Modification
In most states the deductible definition as it relates to allocated expense contains a choice: the customer will be responsible for all allocated expense (structured like this, expenses are “outside the program”) OR the customer will be responsible for allocated expense up to the deductible limit combined with the loss amounts (this is called “inside the program”). Choice of legal counsel and claim settlement authority are two heavily negotiated services that can be provided to the insured depending on whether expenses are “inside” or “outside” the program.
A Loss Conversion Factor (LCF) is a variable that some insurance carriers included in the reimbursement bills to customers. I first explained this in my discussion of Retrospective Plans, but it can apply on LDD’s as well. An LCF is an additional charge (typically 10-15%) on top of the insurance company’s paid amount to cover claims administration costs.
An Aggregate amount is always a consideration on an LDD plan. The Aggregate is the most for which the insured is required to reimburse the carrier. It represents a stop-loss for the insured and, while negotiable, it is typically represented by 2 to 3 times the expected losses for the policy period.
Benefits of a Large Deductible
- Reduced Residual Market Assessments
- Reduced Premium Taxes
- Reduced Premium Based Assessments
- Cash Flow advantage over fully insured plans
- Insurance costs are fixed, subject to audit
- Easy to administer (customer can avoid self-insurance administration)
- Easy conversion to alternative plans
- Tax deductibility of insurance premium and paid losses
- Alternative to assigned risk pool
As always, the selection of any of these plans should fit in with the overall Risk Management scheme of the organization.